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Oil and Gas Price Outlook: Updating Our Near-Term Methodology for Forecasting Prices

In isolation, this will be a valuation tailwind for our coverage, but in most cases it will be modest.

Given the large discrepancy that has emerged between 2017-18 Brent futures prices (currently $40-$47 per barrel) and the Morningstar energy team's outlook for midterm oil industry fundamentals, we are amending our methodology for forecasting near-term oil and gas prices.

Historically, we used strip prices for 36 months (updated regularly) before moving to our midcycle prices, which are set by our long-term marginal cost expectations (unchanged at $70/bbl Brent and $4 per thousand cubic feet Henry Hub).

Going forward, we plan to forecast near-term prices by starting with the current strip and making adjustments only for periods where we have a reasonably high degree of confidence that strip prices do not appropriately reflect our expectations for industry fundamentals. The valuation impact of this approach depends on two factors: the number of quarters we explicitly forecast (as opposed to relying on strip prices) and the variance in each of these periods relative to current strip pricing. We will review our forecasts regularly and adjust prices as warranted by changes in market fundamentals.

Based on our current expectation that oil supply and demand will come into balance in mid-2017, we are launching updated Brent forecasts of $50-$55 for the second half of 2017 and $55-$60 for 2018 (approximately 20% higher than current strip prices on average). We continue to use strip prices for oil until the middle of next year, as well as for all periods during 2016-18 for Henry Hub natural gas.

We will update our oil and gas producer valuations with this new pricing by the end of the current earnings period. In isolation, this will be a valuation tailwind, but in most cases it will be modest, since our midcycle price holds far more weight in determining our published fair value estimates. In many instances this uplift could be at least partially offset by other adjustments, including updating 2016 and early 2017 Brent forecasts since our last published forecasts (given the recent downward pressure on strip prices).

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